Water is a valuable public asset which should be available to all, not sold to the highest bidder to exploit for profits.
Is Your Municipal Water or Sewer System Telling You There Will Be A Big Rate Increase If the System Is Not Sold?
Generally the story goes:
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The system is in dire need of repairs
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Those repairs would require a huge rate increase
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Therefore, we have to sell
If this is what you are hearing, read on
New Garden Township Experience
We experienced the above scenario beginning in 2014 when New Garden Township started evaluating a sewer system sale. Key justification for the sale was that major repairs were needed and that was going to require an almost 80% rate increase.
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What follows are highlights about what we were told and what we have been able to piece together about the need for a rate increase.
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2014 - 2015 The Sales Evaluation Process
In March 2014 New Garden Township announced it would start evaluating a sewer system sale. Very little was communicated during this period. What was focused mainly on what a thorough job was being done.
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Then came 2016 ...
2016 - Announcing The Sale
On April 14, 2016 New Garden Township officials held a buyer selection meeting. A month later they announced at a board meeting that Aqua had been selected as the buyer.
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Then on July 19, 2016 New Garden posted a set of FAQ's (LINK) on its website explaining the sale. A key part of those FAQ's was the investment and rate hikes that would be needed if the sale did not go through. By contrast, Aqua would be contractually committed to much lower rate increases for 10 years. They made it sound like a sweet deal. This was the core of the justification for the sale.
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We have two issues with this:
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First the required investment was likely grossly overstated. This is analyzed in detail here (LINK).
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If any rate increase was needed, it would have been far less than projected by New Garden. Keep reading to learn why.
The Rate Increase Without A Sale
The July 19, 2016 FAQ's announced the following rate increases if the system was not sold:
Aqua's rate at the end of 10 years would be $263/quarter - only a 39% increase. They sure made it sound like a good deal.
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As a side note, no one ever mentioned what would happen in year 11. They should have. It would look something like the chart shown here (LINK)
The Cost To Fund A $12 Million Investment
The normal way a municipality funds capital projects is to issue a bond. Municipal bonds have very favorable interest rates because they are exempt from federal tax. At the time of the sale, interest rates were typically less than 3%. Water or sewer authority bonds are especially safe because they are paid from ratepayer revenue which can be increased as needed to service the bond.
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Using an interest rate of 3%, the annual debt service will depend on the length of the bond as shown in the following table:
For facilities with a long life, 20 or 25 years would be typical. Therefore, annual debt service of $700,000 - $800,000 per year would be required.
Rate Increase Economics
The revenue generated by the proposed rate increase is shown by the following table.
The revenue generated by the first 40% rate increase would more than pay for a 20 year bond. So why would the next 27.5% increase be needed?
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However, even the need for the first 40% is questionable. The following table is a more complete look at New Garden's financial situation.
Check out the red box on the debt service line. The last payment on an earlier bond was going to be made in 2017. That was going to free up over $600,000/yr for other uses. That by itself would have funded 75% of a new $12 million bond.
In 2021 another bond costing $170,000/yr would be paid off. The two combined would cover 95% of the new debt service. And, the sewer system had adequate cash reserves to manage through any short term cash issues.
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There is another major issue mitigating against the need for a rate increase. That is the over $1 million/yr cost to truck wastewater from the South End plant. Part of the proposed $12 million was to eliminate that. In fact, when Aqua bought the system, they promptly invested $600,000 to activate an existing pipeline and eliminate the trucking and its cost. That story is told here (LINK).
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So there was over another $1 million/yr savings that could have been applied to other uses - or even a rate reduction.
New Garden's Financial Forecast
New Garden did provide a 10 year financial forecast. The first six years of it are reproduced in the following table:
Observations about this forecast:
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It looks like the $12 million debt was issued in two pieces: a small part in 2017 and a much larger part in 2019.
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There is a reduction in debt service from 2017 to 2018, reflecting the $600,000/yr bond being paid off.
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After 2021 debt service is about $1.3 million/yr. Why such high debt service instead of the ~$800,000/yr note above? One way to achieve that is to make it a 10 year bond and a $1.4 million/yr payment. It helps make the sale case look attractive.
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Between 2018 and 2022 surplus funds average over $500,000/yr. That says that about 32% of the rate increases are just going to build cash reserves, not pay for improvements. When the sale process started the New Garden sewer system had $4.4 million in cash reserves – over two full years of income. Why would more cash reserves be needed?
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Operating expenses do go down between 2018 and 2019. This most likely reflects eliminating the wastewater trucking expense.
Conclusions
If $12 million investment was really required, it could have been financed over 20 years for little or no rate increase.
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New Garden's own numbers show that much of the rate increase would not be going to pay for the new investment.
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And, as shown here (LINK) $12 million grossly overstated the needed investment.
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What we think this means is that New Garden's rate increase forecast was a scare tactic to justify the sale.
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If your local government wants to sell your water or sewer system and a big rate increase is part of the justification, it is time to ask a lot of questions. This is an area where financial experience is needed. If you do not have the needed skills, try to find someone who does. It is important that the straight forward honest story is told about the economics of the sale.
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